We hear a lot about good policy plans gone wrong (Universal Credit springs to mind) for obvious reasons. But we ought to listen (and learn) from successes too. Auto-enrolment into workplace pension savings is the obvious candidate for this cheery policy tale, though the story has only just begun.
Over nine million have signed up in what represents a clear win for one branch of economic theory: harnessing inertia by taking advantage of an expectation that many more people will fail to opt-out of a savings scheme than would ever sign up to if asked. But the continued success of auto-enrolment is dependent on another powerful economic force: the value people place on the income they have available to spend today, over what they may have in future.
So far this trade off hasn’t been an issue as the minimum contribution level for an auto-enrolled employee is just 1 per cent. That’s precisely how much many new savers are contributing. Even so, the extent to which coverage has increased is phenomenal. As the chart below shows, auto-enrolment has been particularly successful among the low paid and women, who historically have tended to not save at all. Looking across generations, pension coverage is one wealth indicator where millennials are outperforming baby boomers when they were the same age. This is in sharp contrast to Britain’s other big wealth indicator, housing.
These current savings patterns will only crystallise as pension entitlements in the future. For most that is still many years away. By boosting private saving now Resolution Foundation modelling from a recent report for our Intergenerational Commission projects that for future retirees, income will remain broadly stable (see chart below). The State Pension is admittedly doing a lot of the work, but over the long run, income from Defined Contribution (DC) schemes will broadly replace that from final salary schemes (Defined Benefit schemes). Of course there are important differences between the two, particularly the increased risk placed on individuals via DC schemes. However, the future looks far more reassuring than many millennials perceive it to be.
So the long-term outlook for retirement living standards is rosier than many perceive. But we still expect all but the very lowest earners to fall short of the benchmarks for an adequate retirement as set out by the Pension Commission (see chart below). And some generations are more likely to fall short than others. That’s why the moves to boost saving set out today, by starting employees off earlier from age 18 and expanding the range of earnings on which contributions are made, are welcome.
The key to pension saving is to start early. And that’s the problem for many people in the middle of their working lives – caught between the decline of DB pensions and the rise of auto-enrolment. For future retirees from Generation X, auto-enrolment may have come too late, and they’ll see a bigger dip in their post-retirement adequacy as a result. Any move to improve the situation will need to come quickly.
Age isn’t the only barrier to saving enough – the type of work you do makes a big difference too. The self-employed – who now represent one in seven workers – are chronic under-savers. The government is looking closely at how to change this but time is of the essence. Trialling new policy levers asap is a good next step, but firm and decisive action is needed quickly. But that’s going to be tough for the government given the lack of space on the legislative timetable and weak political position to forge a lasting consensus in any policy area.
And of course, the biggest key to saving is the amount being saved – and the amount people are able to save. The interaction between these two over the next few years will hold the key to the ultimate success of auto-enrolment.
Employee contribution rates are set to rise to 5 per cent (including tax relief) by April 2019. That’s a big increase and one that will be needed just to meet the projection we set out above. But here is the rub, saving more now to boost future incomes means a necessary reduction in pay packets today. That’s an increasingly tough choice when we take into account the very weak outlook for wage growth. For a typical worker, the additional pension contributions are equivalent to an over £900 a year drag on pay by April 2019, and a negligible real rise in pay from today.
So far inertia has trumped concern over immediate pay packet effects, an impact that has likely been helped by income tax cuts. Such offsetting support is likely to dissipate in the coming years, though the lowest paid should see some boost from increases in the National Living Wage. Our research has shown that if coverage stalls – falling halfway between pre-auto-enrolment coverage rates and the government’s post-auto-enrolment expectation – up to a fifth of millennials will have lower entitlement when they retire, with the greatest impact among low to middle earners.
The government must stand ready to act to keep private pension savings on track. Precisely how is an issue the Intergenerational Commission will return to early in the new year and one that is key to maintaining the intergenerational contract across all future generations of pensioners.